Is It Better to Inherit Stock or Cash?

Receiving an inheritance of cash or stock presents distinct financial considerations. The better option depends on tax regulations, your financial situation, and long-term goals. Understanding the fundamental differences between these assets, from tax implications to investment strategies, is the first step for any beneficiary.

Receiving an Inheritance of Cash

Inheriting cash is often the most straightforward scenario for a beneficiary. The money received is not considered income for federal tax purposes, so you do not have to report it on your personal income tax return. The amount you receive is the amount you have available to use, invest, or save.

The responsibility for any federal tax on the transfer of wealth lies with the deceased’s estate, not the individual heir. The federal government imposes an estate tax on very large estates, with the threshold set at $13.99 million per individual. Any tax owed is paid from the estate’s assets before distributions are made to beneficiaries.

While the federal government does not have an inheritance tax, a handful of states do. Unlike an estate tax paid by the estate, an inheritance tax is levied on the beneficiary. State-level tax rates and exemptions vary, often depending on the beneficiary’s relationship to the decedent.

The primary advantage of a cash inheritance is its liquidity. The funds are immediately available for any purpose, such as paying off debt, making a down payment on a house, or covering living expenses. You do not need to sell an asset or worry about market fluctuations affecting the value of what you have received.

Receiving an Inheritance of Stock

When you inherit stock, you do not owe income tax upon receiving the shares. The tax implications are deferred until you decide to sell the inherited securities, which is when a taxable event is triggered.

The tax you may eventually owe is a capital gains tax, which is a tax on the profit from selling an asset. For inherited stock, the calculation of this profit is not based on what the original owner paid. A special tax rule applies that can significantly reduce or eliminate the capital gains tax owed by the beneficiary.

The decision to hold or sell the shares will be influenced by this potential tax, your financial goals, and your assessment of the stock’s future performance. The value of the inheritance is not fixed but is tied to the market, introducing both the potential for growth and the risk of loss.

The Step-Up in Basis for Inherited Stock

A primary tax concept for inherited stock is the “step-up in basis.” For a typical stock purchase, the cost basis is the price paid for the shares, including any fees. This basis is used to determine the capital gain, which is the difference between the sale price and the cost basis, when the stock is sold.

For inherited assets, the Internal Revenue Code provides an advantage by adjusting the cost basis. The beneficiary’s cost basis is “stepped up” to the fair market value (FMV) of the stock on the date of the original owner’s death. This rule means that any appreciation in the stock’s value during the decedent’s lifetime is not subject to capital gains tax for the heir, effectively erasing the tax liability on those gains.

For example, imagine an uncle purchased stock for $10,000 that grew to $100,000 by the time of his death. When his niece inherits the stock, her cost basis is stepped up to $100,000. If she sells the stock immediately for $100,000, her capital gain is zero, and she owes no federal capital gains tax. If she holds the stock and sells it a year later for $110,000, she only pays capital gains tax on the $10,000 of appreciation that occurred after she inherited it.

This treatment contrasts with what happens if the stock is given as a gift before death. If the uncle had gifted the stock to his niece while he was alive, she would have received a “carryover basis,” meaning her basis would be the same as her uncle’s: $10,000. If she then sold the stock for $100,000, she would face a taxable capital gain of $90,000.

The executor of the estate can elect to use an “alternate valuation date,” which is the FMV of the assets six months after the date of death. This option is chosen if it results in a lower estate tax liability. This election would also change the beneficiary’s cost basis to the value on that later date.

Financial Planning with Your Inheritance

Deciding what to do with an inheritance requires careful financial planning. You must weigh your need for liquidity against your tolerance for investment risk. If you have pressing financial needs, the immediate availability of cash may be the priority. If you have a longer-term investment horizon, holding the stock offers potential for growth through appreciation and dividends, but also carries the risk of loss if the value declines.

When managing a large stock inheritance, consider diversification. Receiving a substantial amount of a single company’s stock creates concentration risk, tying a large portion of your net worth to one asset’s performance. A common strategy is to sell some or all of the inherited stock and reinvest the proceeds into a diversified mix of assets, like mutual funds or exchange-traded funds (ETFs), to spread out risk.

The best choice involves weighing the tax benefit of the step-up in basis against your need for immediate funds, your investment risk tolerance, and your overall financial strategy. For many, the optimal approach is a combination of strategies. This could involve selling a portion of the stock to meet immediate needs and reinvesting the rest for long-term, diversified growth.